Thursday, October 8, 2009

Mr. Bernanke's Class Warfare

The Fed has been supplying a massive amount of credit to the financial system in order to forestall the effects of the credit collapse. Since the end of 2007 credit extended by the Federal Reserve has jumped 136% to $2.2 trillion.

The Fed has done so by ballooning its own balance sheet, chiefly through the purchase of mortgage-backed securities (MBS), Treasurys and federal agency bonds, plus other direct credit and swap facilities to financial institutions. Here is a comparison of the Fed's major balance sheet assets between the end of September 2009 and a year ago (click to enlarge).

Within just one year the Fed has directly purchased an additional $1.1 trillion of mortgages, Treasurys and agency securities ($700 billion mortgages, $300 billion Treasurys and $100 billion agencies). I should point out that all of these securities are held on the Fed's booksat face value.

In the one year that the Fed's total assets have increased $640 billion, its own capital has increased by a mere $10 billion, to $51 billion. In other words, the Fed's Asset-to-Capital ratio has gone from 36x to 42x, even as the quality of its assets has demonstrably deteriorated. Mortgages and agencies now make up 40% of its assets, up from a mere 1.1% a year ago.

This massive expansion and radical transformation of the central bank's balance sheet is the direct result of Mr. Bernanke's theory that the Great Depression happened because the Fed did not immediately provide enough liquidity and credit to the financial system in the aftermath of the 1929 Crash. In his view, this eventually precipitated bank failures, the evaporation of depositors' savings and the transformation of a financial crisis into an economic collapse.

I am not going to argue with Mr. Bernanke's eminent academic research; his historical analysis of the 1930's is probably spot on. But I have an increasingly growing suspicion that this analysis - and thus, his current actions - are irrelevant to today's situation; that Mr. Bernanke is a general trying to fight today's war with yesterday's tactics and weapons.

My oft-repeated premise of this reasoning by false analogy, is best exemplified by the French wasting enormous resources to build the Maginot Line before WWII, a superbly constructed and equipped static fortification, only to see it immediately by-passed by Guderian's blitzkrieg panzers in 1940. Why were the French so short-sighted? Because they became mesmerized by their analysis of WWI trench warfare, when millions of their youth were massacred defending or trying to capture ill-equipped trenches. The response to their flawless analysis of the past was, however, entirely irrelevant to their future.

Likewise, there are major differences between today and the 1930's, chief among them:

The U.S. was then the largest creditor nation - today it is the largest debtor.

The economy was then based on manufacturing, farming and capital investment - today it is based on consumer spending.

The saving rate was then around 18% - today it is 4% and a couple of years ago it even was negative. The vast majority of people today don't have significant savings to lose; instead, they owe debts that are choking them and the economy.

Inequality is rampant : today 90% of all American families have median financial assets of $132,00 or less, whereas the top 10% have $405,000 (2007 constant dollars). In gross terms, then, 90% of all families are more than likely covered by FDIC's $250,000 deposit insurance (Federal Deposit Insurance Corporation).

By contrast, debt has exploded upwards: families now owe an average $126,000, more than double the $58,000 twenty years ago - and that's in constant 2007 dollars. If we look at just the middle class, i.e. the middle 70% of the population excluding the bottom 20% and the top 10%, things look even worse (see table below - click to enlarge).

I'm afraid that Mr. Bernanke's actions at the Fed end up preserving debt, owed to the top 10% of the population by the other 90% of the people. His measures are not really designed to safeguard the savings of that 90%, simply because they don't exist in any serious amounts.

Maybe Mr. Bernanke can justify his actions as "saving the financial system", but a cynic could easily perceive them as Class Warfare. Because, it is one thing if a private financial institution comes to the rescue of the financial system with its own money, much as J.P. Morgan did in the Panic of 1907. But it is another thing entirely when a public institution bails out a tiny percentage of financiers and mega-rich from a disaster of their own making, and then bills the entire operation to that 90%+ of the people who had nothing to do with it.

Worse than that, worse than being ethically wrong, Mr. Bernanke's actions are also economically useless. Sure, a couple of trillion in ready liquidity has deflected the liquidity crisis, just like couple of aspirin can bring down fever. But fevers and liquidity crises are symptoms, not diseases and the economy's real problem is simply too much debt relative to peoples' income.

Look at the income distribution table below and compare it with the debt table above (click to enlarge). For example, look at the 80-90 percentile: real median family incomes have increased 19% in 20 years from $95,700/yr to $114,000/yr, but debt has increased 188% from $63,300 to $182,200. Things are even worse at the lower percentiles.

Bottom line: Mr. Bernanke is solving nothing by socializing and preserving debt, by substituting bad mortgage debt with federal debt, which we then all have to service and repay.

Instead of ballooning the Fed's balance sheet and engaging in de facto class warfare, Mr. Bernanke should look for ways to reduce families' debt load, most likely through partial forgiveness and default. He can't do that by himself, of course; that's a job for Congress and the President. But, at least, Mr. Bernanke should not make it easy for zombie debt to keep existing and choking American families through the public's enforced largesse. He didn't ask them, did he?

47 comments:

You communiss Hell, don't you know the libruls caused this mess by giving easy Federal backed mortgages to minorities, and everything would be fine if we went back to the gold standard, and oil is on its way to $20/barrel.

Absolutely right. We need massive cancellation of debt--a Jubilee Year. To give it the best shot of passing Constitutional muster, it should take the form of an extreme liberalization of the bankruptcy law.

Don't be too tough on poor Bernanke. IMHO, he's doing the best he can with the tools he has and the constraints on him. As you say, it's Congress and the President who should be acting. I am not optimistic.

this is a great article. I agree that the govt is creating another bubble. I am completely confused on how to protect myself. I see that gold is shooting up (i hold 5% of assets in gold) but if there is deflation this should go down. If the US economy stalls as this article implies, all the export oriented economies Gulf, Jpn, Kor, Chn will tank because their local economies are not good. so buying their currencies may not seem like a smart idea. the dollar is depreciating and effectively "losing" some of the stock market gains. the earnings surprises in the banks should end in q4 and the rest of the guys will follow...

Yeah, I'm confused about that, too. We have massive foreclosures going on, hello? The idiots who bought overpriced homes mailed in the keys already, leaving the bank to hold the bag. These ex-McMansion owners get the humiliation of losing their home, a blot on their credit rating, but learn the wisdom of saving money while renting over the next few years. Sounds fair to me.

The rest who didn't buy more house than they could afford are doing mostly okay thanks to record low interest rates.

So I don't see what Bernanke should do differently, here. The banks are getting the brunt of it due to foreclosures, not homeowners.

While I agree with the truth of everything you say. You know better than anyone that this is only one perspective on a zero sum issue.

There are a near infinite number of perspectives that could refute this post.

As but one further difference, you also conveniently forgot to include the differences in the tax codes between the 1930's and today as well as the relative % GDP controlled by government and who funds this government spending.As this too would have a VERY significant implications re: class warfare and any notion of fairness in all this mess.

I know you want your cake and to eat it too (and to not look like a self serving in the process), but the zero sum nature of life (and the market) does not allow the rest us of to be so easily fooled.

What are some of the major factors for wage disparity? An outsized and corrupt finance sector skews the upper end. The upper class is more able to invest a larger proportion of their income. This disparity was augmented by the credit bubble and housing bubble. Also, the pareto principle always holds to some extent.

The upper-middle and upper classes shoulder the lion's share of the federal tax burden, the lower and lower-middle class shoulder a very small fraction of the federal tax burden. Healthcare reform would plummet in popularity if all working Americans had to pay proportionally more in fed taxes. Of course most people would vote for a free lunch, only to find out they end up paying for it later.

Liquidating some of the debt is probably the best solution, but the politico-oligarchs will exert their power to stop or minimize that path. That has nothing to due with the wacky, ancient concept of jubilee. No, we are going to do this the hard way. No revolution in modern America. Excessive socialism will only drive the capitalists to Asia where the superpowers of tomorrow will exist.The Chinese and Indians laugh at the idea of greenhouse emissions restriction.

American wages in real terms are not going up, not in a global economy. If you want protectionism, so be it.

DRINGGGG....Students to their seats, please. The semantics lesson begins.A few months ago, Nicolas Sarkozy even managed to stir the ire of Oussama JUST BECAUSE he said ONE SENTENCE that got many of the human animals on this planet to jump to attention with their machine guns cocked (and pitchforks for those with no machine guns). What did he say ??? That full fledged veils (from head to foot covering the face) were not WELCOME in France. Fireworks erupted all over the planet.And now, what has poor Hell done on this blog, just by using that BIG word, FORGIVENESS ???THE SAME THING.Lots of fireworks on this blog at the very mention of the word FORGIVENESS.At times like these, I REMEMBER MY CHRISTIAN HERITAGE, even if I'm not practicing anymore.No generosity, no forgiveness, all cynicism these days. People may be going to church and paying lip service to their God, but they certainly aren't translating the Gospel into acts.That's what's bringing this country down.Everybody wants to make everybody ELSE PAY.And Thai, for once I will NOT defend you in your comments on Hell's post which is excellent, and historically sound.Zero sums may work on a GLOBAL level, Thai, but when you start going into the particulars, there's lots of room for differences that should be taken into consideration.

A. Not looking for a defender but thanks for at thinking about it before you said "you're on your own".

B. You are correct to recognize that a linguistic association was "set off" in this particular primate's mind so to speak, but the association has nothing to do with the word forgiveness at all.

I think you may be interpreting my comments in light of your own personal interpretation of this link.

And re: "Zero sums may work on a GLOBAL level... but when you start going into the particulars, there's lots of room for differences that should be taken into consideration."

Do you mean:A. There are lots of interpretations as to how we got into this mess? In which case I would agree)B. There are lot's of solutions on which we can cooperate in order to get out of it? In which case I would agree. C. Both A and B? In which case I would agree.D. ANY or all of these choices (such as B) is not zero sum? You know what I would say

I am actually quite optimistic about the future and think the majority of this pessimism is quite unwarranted.

And as I have said before, at least from my particular point of view/perspective (remember the Puritans????), to the extent this credit crunch does lessen global focus on materialism and Bacchanalian pursuits, it will be a good thing.

I agree with the thrust of your argument, Hell, but think of it this way. If the Fed didn't electronically transfer money to the Treasury, the government would have two options: raise taxes or cut spending. Given that they're not going to cut spending, they'd be raising individual taxes, or Social Security taxes, or Medicare taxes (it all goes to the same place.) Do you really want your taxes raised?

I know that this is an unstable system, but it always was unstable. All we can do is play the cards they deal us.

This is what the conservative Jesse at Jesse's Cafe has to say. Which lines up with what I have been saying. Doomer you say, not really, more like realist.

"There are going to be more crises, more dislocations associated with this, despite the best efforts of the financial engineers to paper it over, and the captive media to cover it up, dismiss it, and move along to the next asset bubble in stocks.

This is what gold is telling us. It is saying that the era of the US Dollar as the world's reserve currency is ending, with all that this implies with the balance of power in the world as it has existed since the end of the Second World War."

As everyone know these days - credit money is created when a loan is made. That money ends up in someone else's hands. And what people fail to understand is that the mirror image of over indebtedness is greater concentraion of wealth in fewer hands.

'Trickle down' has failed to work. There has to be balance between borrowers and savers, debtors and creditors, importers and exporters, rich and poor - such that the one can trade with the other, sufficient to service their debts. Hoarding has occurred - i.e. the rich are getting richer - the only means of restoring balance are debt forgiveness, inflation or taxes.

The traditional method of restoring balance thru' the tax system has disappeared with globalisation and offshore tax havens. So they've resorted to taxing anyone they can find.

So, which method for restoring balance would you like to see?

(I should add I'm not a lefty by any stretch of the imagination - I've come to this awkward conclusion from an understanding of money.)

Go back to the beginning of Hell's blog, when he first started writing. Hell was prepared for this while obviously most others were not.

Debt forgiveness would/will not personally effect him.

Classic "...eat my cake too" ;-)

@Hell

Please be fair

I might remind you that you are the one making "the real economy" and energy as the basis of society and life argument.

And re: inequality

"Yes and No".

I think the crux of where we may differ is in two statements you make:

1. "My position, however, is that certain actions and conditions tend to significantly lower or increase inequalities."

I would say life and society are a chaotic systems that at best we can have some control over sometimes and to the extent we become overly confident in our ability to control society, it makes it that much worse when "shit happens".

As but one example: I ask some of my patients with HIV to inform their partner's and use protection.

Sometimes they just don't listen (by the way, if this persists as FYI I am now legally required to inform the police. Society has decided on its own that doctor-patient confidentiality has limits).

And of course afterward the rest of us have to decide how we want to spend (read consume) the fruits of our labor to "solve" the situation- as if there are any good solutions.

2. "... That's dynamite at the foundation of society."

My response: It is the assumptions that go into this statement that mark the entrance to the rabbit hole.

We are consuming more in health care. We are consuming more in retirement. We are consuming more in education. We are consuming more in housing. We are consuming ore because we are living longer (if obesity does not start to reverse the trend, as a society we are gaining something like a month of life every single year).

Isn't dollar hyper-inflation essentially debt forgiveness?Isn't that the net result of what Ben is doing?

Your analysis is spot on, we need renewable energy independance and back to making things again, and exporting. But aren't big corporation today are highly global, they can care less about the USA specifically?

People often forget, or are not aware, that a very large portion of debt is today adjustable rate, e.g. ARMs, or very short-term.

This is even true of Treasurys. Of the $7 trillion outstanding, Tbills and TIPS are 2.6 trillion, notes up to 5 years in maturity are 3.7 trillion and only 700 billion are bonds, i.e. over 10 years in maturity.

Ladies and gentlemen, I have said this b4 and I shall repeat it again: this is NOT the 1980's and debt CANNOT BE INFLATED AWAY.

But why can't the Fed just purchase ANY outstanding long term America debt?

Does it matter if it is public or private?

Aren't many people converting their ARMs to long term mortgages?

Why not just purchase these?

Or for that matter, why not just have the government issue new 30 year notes and increase governmental spending and then have the Fed purchase these notes? e.g. the Keynesian-monetarist cooperative model?

Or just purchase long term state debt (say) in proportion to the US population of each state?

Many states currently have unfunded pensions liabilities right now, no?

It seems to me we can always make or find long term US debt to print shiny new fiat currency with IF we just cooperate, no?

And re: "It's fine to have fractals... but should they be 95-5% ? That's dynamite at the foundation of society."

I sense you may be misunderstanding my point.

My point is simply that it is what it is.

If someone moves into this rich country as a result of economic changes from a poor country with (say) only a nickle in their pocket, this clearly increases US inequality.

But is this instance of inequality a bad thing?

I think we both know there are many perspectives on this issue. I sense they all have an air of legitimacy.

I don't deny the "dynamite at the foundation of society" one bit, but we must deal with the hand we were dealt as well.

Indeed I noticed you posted my old physiology professor Jared Diamond's book on your website so you seem to have a cognitive dissonance in this arena- e.g. you seem to admit the existence of complex/chaotic systems in environmental sciences, but deny them in the social/moral/mental sciences, etc...

To quote from the article I reference above:

"Every extra layer of organization imposes a cost in terms of energy, the common currency of all human efforts, from building canals to educating scribes. And increasing complexity, Tainter realised, produces diminishing returns. The extra food produced by each extra hour of labour - or joule of energy invested per farmed hectare - diminishes as that investment mounts. We see the same thing today in a declining number of patents per dollar invested in research as that research investment mounts. This law of diminishing returns appears everywhere, Tainter says.

To keep growing, societies must keep solving problems as they arise. Yet each problem solved means more complexity. Success generates a larger population, more kinds of specialists, more resources to manage, more information to juggle - and, ultimately, less bang for your buck.

Eventually, says Tainter, the point is reached when all the energy and resources available to a society are required just to maintain its existing level of complexity."

Thai, I see NO ROOM WHATSOVER for history/temporality in your model, which seems to me abstract and, more importantly, universalist. To me, universalist models are generalizations which are epistemologically incorrect.Hell is speaking from an historical perspective, and you from a universalist one. You are NOT going to agree. Not the way I understand it, at least.And I can't help thinking of Leibniz"s theory, a theory that excited Voltaire's contempt in Candide, when I read about fractals. Marcus, no point in dumping on Thai just because you don't understand him...

Hey that's really tempting bait ya got there Debra, but I'm sorry if you want to criticize Thai you're going to have to strap on a pair and do it yourself. I am impressed with that big red fish he studied under though, can't argue with that.

OK I'll swim to the surface and toy with it a little bit: I think his first question is the kind that makes Hell break open the scotch early

Wonderful wonderful post. A lot of people are beginning to understand what is going on. I don't know whether there will ever be enough people to make a difference but, with the internet there is a chance. Anyway people like you have to keep on trying. I try to think of how to take effective action, given that there are no "solutions" in the ordinary sense. Of course we can try to prepare ourselves and families for the short term at least via survivalism or localization. But I have the sense that the leaders of the world's nations are working at extraordinary cross purposes and, as you say, are making things worse through malevolence or ignorance or some nasty combination of both!How do we educate the politicians? I don't think that they are all corrupt cronies. Most of them are clueless about economics and history. Perhaps groups of constituents should try to get to their staffers with books and blogs. Positive change is never going to come from above - witness the Obama disaster. Does anyone else find it weird to be going through the days, weeks and months as though the future were going to resemble the past while knowing that it can't? Unsettling!

Hell commented: "Ladies and gentlemen, I have said this b4 and I shall repeat it again: this is NOT the 1980's and debt CANNOT BE INFLATED AWAY.

The ONLY way to get rid of debt now is to default/forgive it."

Just to add to that. Dollar bills are 'claims'. You can't print dollar bills to repay 'claims'. You just end up with more claims.

You can 'buy back' your dollar bills by issuing debt. And that is what the US has been doing. Now we're printing to buy the debt back. And there are now more claims out there.

Hell is right. The governement can print and cancel debts. Still, leaves an awful lot of claims out there. What happens to prices will depend on how people with the money perceive that - will they want to get rid of them as quickly as possible to swap for real assets?

YOu are somewhat on line with this, but there is more. There are a lot of well to do that are using massive leverage themselves. Many are going to dig in and borrow more, believing they can get even richer. Much of the debt is actually held by institutions, much of which is in the hands of the middle class, the stock being held by the wealthy.

Bernanke is behind the 8 ball because the Fed and government has been fighting deflation for close to 20 years now. I am going to write something to reason this out on my blog. The idea revolves around the rapid decrease in interest rates in the early 1990's and something I read in the report on the pending losses in the FHA by Mr. Pinto, the former risk guy at FNMA from back in the 1980's. It appears that they couldn't really explain why there were so many defaults in housing in the 1990's even though the economy was good. You might note that the 1920's were a great moderation as well after a Fed chairman wrong inflation out of the market in 1920.

What few understand is that the debt is bad and Bernanke can't swap the loss. What he can do is drag more people into the mire, which the stock market appears to evidence is happening. The problem today is the debt is such a multiple of GDP that debt service in general means very little. The debt itself can't be repaid.

To add more. Hellacious is correct about you can't inflate this. The Fed's purpose of buying debt is so the banks can issue more debt at lower interest rates. The mess has its roots in the 1970's and Paul Volkers high interest rate policy to stop inflation. The inflation of the 1970's was demographic and was caused by excessive lending. The banks are overleveraged and by selling debt to the Fed are keeping their liabilities while giving up their interest bearing assets. Banks have no money in excess of what they already owe, so the idea they have more to lend is based on an old wives tale. The assets bought by the Fed don't cease to be serviced as well. It is the holding of performing assets that gives the Fed any power at all, so they can't just print money and forgive debt. The purpose of the Fed in the first place was to remove the limitation on banks to create money by creating a standardadized note. Thus one banks paper wasn't inferior to anothers when presented as currency. For those that don't know, banks held loans and gold and printed redeemable currency, usually too much of it.

Comments to LynnHarding, and Hotair :Lynn, I have been into downsizing for quite some time now. I am "playing" : like... how to do more and more things WITHOUT resorting to money (and that means offering things without asking for monetary compensation, too...).If you look around you, people, you will see that more and more instances of gratuity are arising. These are the signs that we are tired of this system.Hotair, as for hoarding pieces of paper (or gold, Joe..) or investing in assets, and particularly objects, I think that many people are MORE interested in divesting themselves of their fiat currency in favor of more satisfyingly tangible "things".And one last point : what is the LIMIT on this whole shebang, and when is it going to appear ? So far, NO LIMIT has appeared. (Marcus, yes A limit has appeared for those whose houses have been repossessed...) Kind of like, we need to collectively convince ourselves that there IS a limit.Is there ? Isn't there ?Well, the day that dollar is presented in exchange for goods and services, and it is... REFUSED, that's when the limit appears, right ?(Chances of that happening WITHIN the country are pretty slim now, aren't they ? But... OUTSIDE the country, that's a different story.)Until then... STILL NO LIMIT ?

"If the Fed continues to apply monetary stimulus and subsidy into this system, without a significant reform, the dollar will eventually "break" and the real economy will temporarily collapse. This will result in the mother of all stagflation, with a hyperinflationary edge to it, and a breakdown in the electoral process, the rise of demagogues, and soaring interest rates.

At this point the cure will not be a monetary stimulus, but more like a surgery to remove a life-threatening cancer, fraught with risk and a significant challenge to the continuing governance of the US not seen since the 1860's."

This event could be only weeks away. At least, prepare for the possibility.

Joe, if the dollar breaks the first thing that would happen would be those things that import would skyrocket in price- most importantly oil. E.g. the market will force what all the greens in the world have been unable to do on their own.

Joe, I was thinking about your comments re: doom and gloom tonight and the difficulty in predicting the future...

I am not sure you have the same interest in chaotic systems, or fuzzy logic, non-linear systems with fat tail probabilities, fractals, evolutionary psychology, AI, etc... that some of the rest of us have, but to the extent you follow these discussions I ordered a book from amazon.com the other day after coming across this article.

In particular, what caught my eye was twice the predictive accuracy of the best CIA analysts validated in prospective vs. cohort studies (which to a physician makes all the difference- we will put novel drugs in a person's body with that type of study whereas most of the other stuff we discuss on this blog is really cohort type data and at best interest).

Anyway, I would be willing to bet good money someone who manages as much money as Hell has already paid Bueno de Mesquita to predict the behavior of the Fed in the same manner that he predicted Iran's nuclear ambitions.

Perhaps we can all cooperate enough to start a blog collection purse (after we tip Hell of course) to see if we can purchase a prediction?

Hell, what do you think a prediction might cost? In for a penny, in for a pound?

If the model is already built it might not cost nearly as much as a unique prediction would likely be ;-)

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.